Tough Choices on Retirement

Legend has it that when Henry Ford went into the business of mass producing cars, he said that customers could have any color they wanted, as long as it was black.

Lack of choice actually can be a good thing because you know what you are getting and you don’t have to expend much mental energy or time exploring the possibilities. Also, you will never risk having a nagging feeling that you could have done better.

Retirement, however, comes with a range of choices and it does require research and mental energy and there is a real possibility that you could have done better.

A Government Accountability Office report looked at several key retirement-related decisions, consulted financial advisers and other experts, and concluded . . . well, that it’s a matter of making difficult choices.

Some are less difficult than others, though. One topic it examined involves what to do if you change jobs before you are eligible to draw retirement benefits. Commonly, for those who have defined benefit retirement plans (and that includes FERS and CSRS) one option is to pull out a lump sum amount in cash, at the cost of forfeiting entitlement to a later benefit.

For federal employees, this almost never makes sense. A defined benefit is an increasingly scarce employment benefit in today’s economy, and all projections show that trend continuing. If you were to leave the government before retirement eligibility, you could leave the money in the retirement system and qualify for a benefit later, typically on reaching age 62. That benefit will not be as generous, since it will be calculated according to your years of service and high-3 salary level when you left, and won’t be adjusted for either inflation or wage growth. Still, it will be something.

Typically, withdrawing your retirement contributions as a federal employee makes sense only if (1) you have fewer than five years of service, in which case you won’t qualify for a deferred benefit and (2) you are absolutely sure that you will not return to the government. But life plans do change, and even then you could end up returning to the government at some point, getting at least the minimum five years, and having to buy back what you drew out, with interest, in order to capture your prior service time.

Another key decision, according to GAO, is whether to use some of your retirement savings through a 401(k) type plan to purchase an annuity. For some people, although not federal employees, this is an especially attractive option because they will not receive a defined benefit from a former employer and buying an annuity is a way to guarantee a stream of income for life. It also shifts the risks of investment from the individual to the annuity provider.

The report said, though, that only about 6 percent of those with such accounts buy annuities, in part because there is a risk of dying early and not getting back, either as an individual and/or through survivor benefits, the amount invested to buy the annuity.

For federal employees, buying an annuity is one of the TSP withdrawal options. But far fewer than 6 percent traditionally have withdrawn their TSP money in that way—the percentages are in the low single digits—in part because the FERS or CSRS benefit already provides that type of guaranteed benefit. Also, the annuity option is by far the most complicated TSP withdrawal choice, and there are also are the same considerations about not getting back the value of what you put in. There are ways to insure against that risk in the TSP annuity, but of course that comes at a cost.

For those who are eligible for a Social Security benefit—and this now includes more than nine-tenths of federal employees—another key decision is when to begin drawing those benefits, said GAO. Benefits can begin as early as age 62, although there is a financial benefit to waiting until “full” retirement age, which currently is 66. That advantage will get larger in the future, as that age increases and the reduction for drawing benefits before that age will increase accordingly. There is also an additional bonus for waiting past full retirement age, up to age 70.

In practice, about half of retirees begin Social Security benefits at age 62, and only about 3 percent defer past their full retirement age. This pattern has changed relatively little in recent years, it said, even as the phasing up of the full retirement age from 65 to 66 (eventually it will rise to 67, under current law) was underway. Put another way, retirees tend to want the money as soon as they can get it and are willing to live with the reduction even though the reduction is greater than it used to be. But GAO said the experts it consulted generally recommended not drawing benefits as soon as possible.

Other decisions also have major implications: Should you buy long term care insurance to protect against possible major expenses for nursing home care or other assistive care? At what rate should you draw down retirement savings? What mix of investments should you maintain after retirement? How should you structure your benefits and finances to the best interests of your survivors after your death?

Pondering those choices almost might make one wish that Henry Ford were in charge.